5. Consider trade relations between the United States and Mexico. Assume that the leaders of the two countries believe the payoffs to alternative trade policies are as follows:

a. What is the dominant strategy for the United States? For Mexico? Explain.

b. Define Nash equilibrium. What is the Nash equilibrium for trade policy?

c. In 1993 the U.S. Congress ratified the North American Free Trade Agreement (NAFTA), in which the United States and Mexico agreed to reduce trade barriers simultaneously. Do the perceived payoffs as shown here justify this approach to trade policy?

d. Based on your understanding of the gains from trade (discussed in Chapters 3 and 9), do you think that these payoffs actually reflect a nation’s welfare under the four possible outcomes?

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United States Decision Low Tariffs U.S. gains High Tariffs U.S. gains $25 billion $30 billion Low Tariffs $25 billion Mexico gains Mexico gains $10 billion Mexico's Decision High Tarrifs U.S. gains $10 billion U.S. gains $20 billion Mexico gains $30 billion Mexico gains $20 billion